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Dollar Cost Averaging: What is it good for?

Dollar cost averaging provides an advantage for lowering your investing costs over time, which are best used to reinforce a healthy wealth building habit rather than to determine when to invest a lump sum.

Even the phrase “dol­lar cost aver­ag­ing” should put most peo­ple to sleep. Yet, here it is.

Dollar cost aver­ag­ing is an invest­ing “strat­e­gy” that basi­cal­ly says, if you invest the same amount reg­u­lar­ly over time, some­times you buy high and oth­er times low­er. Because you’re invest­ing the same amount of mon­ey each time, when prices are low­er you buy more shares. The way aver­ages work, that means your aver­age pur­chase price is weighed down (which is the right direc­tion) because you buy more shares at the low­er prices than you do at the high­er prices.

That’s a mouth­ful (or para­graph-ful as it is).

I came across an arti­cle on Money Badger (a site you should fol­low, as it has good edu­ca­tion­al mate­ri­als) about dol­lar cost aver­ag­ing with a video explain­er that’s use­ful.

However…

There’s always a ‘how­ev­er’, isn’t there? (It’s because I ask good ques­tions.)

However, I dis­agree with the exam­ple they use. Or rather, I don’t think there exam­ple is the most rel­e­vant.

They start:

Let’s say you have $12,000 and want to invest

And go on to tell you to invest $1,000 per month instead of invest­ing all at once in order to cap­ture the ben­e­fit of dol­lar cost aver­ag­ing.

If you were to invest in a div­i­dend pay­ing stock, you’re miss­ing out on a cou­ple of per­cent­age points of return by wait­ing (because you’re not get­ting all the div­i­dends on the unin­vest­ed amount). And, you lose the pow­er of a year of rein­vest­ments and div­i­dend growth (so, your pay­check growth over the course of the year could be about 10% if you invest­ed all at once), if that’s what you choose (and you prob­a­bly should). So, I’m not con­vinced that if you have a lump sum to invest, the best thing to do is spread that invest­ment out over a year. Not to men­tion that many peo­ple would prob­a­bly spend that mon­ey over time if it’s acces­si­ble in a sim­ple sav­ings account wait­ing to be invest­ed.

Creating healthy wealth-building habits

Where dol­lar cost aver­ag­ing is real­ly help­ful is when try­ing to cre­ate an invest­ing habit.

Habit for­ma­tion is an inter­est­ing top­ic as it relates to invest­ing. I talk about it in my book because it’s impor­tant to cre­ate a suc­cess­ful habit for­ma­tion loop in order to devel­op a dis­ci­pline around invest­ing. And, you’re not going to cre­ate a new habit if the habit is not reward­ed (and it’s not reward­ed if each time you invest you feel like you’re los­ing).

Dollar cost aver­ag­ing comes in as anoth­er way to rein­force the habit. If you set­up an auto­mat­ic month­ly invest­ment, dol­lar cost aver­ag­ing helps you under­stand why you don’t care about the exact pur­chase price because over time you ben­e­fit by a low­er aver­age cost of pur­chase.

Said dif­fer­ent­ly, you might face two choic­es — buy $50/month auto­mat­i­cal­ly, or put aside $50/month and buy when you think the price is “good”. Putting aside that you’d nev­er real­ly know what that good price is… and the fact that a small price change over a $50 invest­ment real­ly isn’t much… if you buy reg­u­lar­ly and auto­mat­i­cal­ly, you’ll ben­e­fit emo­tion­al­ly with few­er deci­sions to make, and you’ll ben­e­fit finan­cial­ly with dol­lar cost aver­ag­ing low­er­ing your aver­age cost over time.

Building healthy finan­cial habits is hard, just like los­ing weight or any oth­er long-term habit that’s try­ing to change a con­di­tioned behav­ior. Every lit­tle bit helps and that’s why if you can get your head around dol­lar cost aver­ag­ing, it’s worth watch­ing the video on Money Badger.

If you’re look­ing to get start­ed devel­op­ing a per­son­al finan­cial well­ness plan, have a look at my free email course Money Making Money.

Money Making Money

I wrote a free email course specif­i­cal­ly for peo­ple who want to get start­ed invest­ing. In it, I will teach you how to get start­ed with as lit­tle as $10 using Stockpile, and then walk you through my unique met­rics designed for you to have fun and stay moti­vat­ed to build a healthy invest­ing habit.

Course atten­dees can down­load a spread­sheet tem­plate that I’ve cre­at­ed to high­light these met­rics. I even share a tuto­r­i­al that you can use to set­up your own track­er.

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About David

David Bressler is a tech executive who began offering financial coaching after noticing how little people know about investing. Since then he has made it his mission to help as many people as he can learn how to build sustainable wealth and gain financial flexibility.

Bressler, who earned his MBA at New York University’s Stern School of Business, writes and speaks about how adopting a few simple habits can dramatically improve your financial future. He lives in New York City with his wife and two children. The Elephant in the Room has a Paycheck is his first book.